Economist, Telegraph Columnist, Broadcaster

“Bail-in” that throws the euro’s future into doubt

“This sucker could go down”. So said George W. Bush back in 2008, at the height of the global financial storm. The then US President was referring to the massive risks facing the world’s largest economy following the Lehman collapse. Could Dubya’s prosaic words now be applied to the euro? Will Cyprus quit the single currency?

The “bail-in” deal imposed on this tiny Mediterranean nation last week is better than the one mooted less than a fortnight ago. The lunacy of penalizing insured deposits, those under €100,000, has been avoided. While the atmosphere in Cyprus is tense, it is also obviously a relief that, since the banks re-opened their doors last Thursday, after almost a fortnight shut, there’s been no serious civil unrest.

At Laiki Bank, the island’s second-largest, deposits above €100,000 are being slashed by up to 80pc. Similarly uninsured deposits at Bank of Cyprus, the biggest bank in the country, will suffer 40pc losses. All savers, meanwhile, are subject to stringent controls on withdrawals, including a €5000 monthly limit. Cypriots travelling abroad can take just €1,000 with them and import payments must be approved by the central bank.

Cyprus marks the first Eurozone banking crisis that is being “resolved” without a seemingly limitless reliance on taxpayers’ money from other member states. A distinction is being made between solvent and insolvent banks, with bondholders at the latter taking a very big hit. That is how it should be. Next time, such investors will pay more attention to the financial health of the institutions they back.

Had uninsured savers also been stung, those with deposits below €100,000, that would have breached a Eurozone guarantee extended just a few years ago. It would also have spread panic and even political extremism across Europe, as tens of millions of households took fright at the security of their savings.

Having said that, I still have a very big problem with the large depositor write-downs. Depositors are not bondholders – who knew their money was at risk and reaped a commercial yield on their investment. On the contrary, depositors put their money in a bank, at a lower rate of return, precisely to keep it safe.

While the Brussels PR machine endlessly talks of “Russian oligarchs”, the reality is that €100,000 is not a huge amount of money. Across Cyprus this Easter, hundreds of family-owned businesses are trying to come to terms with what they see as the theft of their working capital. Numerous charities, universities and other educational endowments have also been whacked. As I said, depositors are not investors. There is an absolutely crucial distinction between them – or, at least, in a modern society, there should be. Moving on any depositors, large or small, seriously undermines the financial and legal fabric of capitalism itself.

The only reason there hasn’t been a massive bank-run in Cyprus in recent days, of course, is the draconian capital controls applying to all banks. While these are supposed to expire at the end of this week, there is absolutely no way this will happen. As soon as controls are lifted, such money as remains in Cyprus would take immediate flight. As long as Cyprus remains in the euro, such controls are almost certain to stay in place.

By are they compatible with single currency membership? How long will it be before euros in Cyprus are worth less than those that can be spent across the other 16 member states? And are capital controls even legal? Articles 63 and 65 of the European Union treaties say such controls are justified “only on grounds of policy or public security” and should “not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital and payments”. How long, then, before some of the very large international business interests caught up in this Cypriot banking chaos get together to launch the mother of all legal disputes?

What is happening in Cyprus throws the future of the euro into doubt in many other ways too. Dutch finance minister Jeroen Dijsselbloem, who heads the Eurogroup of eurozone finance ministers, has asserting that the Cypriot “bailing-in” of both bondholders and uninsured depositors should be a “template” for the resolution of banking crises in other member states.

This is just what you’d expect from the head bean-counter of a Calvinistic, solvent country which still enjoys a triple-A sovereign rating, and where voters are sick and tired of shelling-out to clean up after fiscally incontinent eurozone members.

Numerous other members of the Eurogroup of Finance Ministers, though, were were quick to contradict him, asserting that Cyprus was a “special” or “specific” case. That’s hardly surprising, given that they represent countries which themselves could easily suffer from massive capital flight, their banks awash with red ink and their exhausted sovereigns, having propped up said banks for years, fiscally incapable of doing much more.

Since this Eurozone crisis began, a view has emerged, not least among the single currency’s most stringent advocates, that the edifice could only be held together with the advent of “fiscal union”. This is an argument I accept. I’m starting to lose patience, though, with those who expect to be taken seriously when they venture that such an arrangement can actually be implemented in Europe.

Spain is a democracy. Italy is a democracy. France, the world’s fifth-largest economy, is a democracy. Are all these countries, their electorates supplicant, really going to subscribe to and live under, for decades to come, a system based on Germany telling them how much they can borrow and spend? I think not.

Monetary union, also, requires “banking union” we are told. Is that really going to happen? Do current events in Cyprus make it more, or less likely? The answer is obvious, for anyone prepared to see.

It is abundantly clear that the Eurozone, the world’s second-largest economy, is now the region most likely to spark a systemic lurch on international markets, taking us back to a “risk-off” environment, so stymying investor sentiment right across the globe.

While attention is focused on Cyprus, we shouldn’t forget that in Italy a government has still not been formed. Beppe Grillo’s deeply Eurosceptic Five Star Movement, enjoying a wave of popular support, continues to reject offers of coalition from the centre-left.

In Slovenia, too, trouble is brewing, as sovereign bond yields soar, with markets focusing on banking sector weakness. Most Western Europeans don’t even realize Slovenia is in the Eurozone. But they could soon be hearing a lot more about Austria Southern neighbour. Having adopted the euro as recently as 2007, this fiercely independent country is perhaps more likely to leave the single currency than put up with being pushed around by larger member states. And once the myth has been broken, and euro membership is shown not to be forever, market speculation could make other exits unstoppable.

For any nation, leaving the euro would be a chaotic affair – involving forced deposit redenomination, bank-runs, collapsing “new” currencies, soaring inflation and a whole world of legal disputes. But social and political pressures could yet bring Cyprus to the point where this seems a better option than staying in. Or, the markets, of course, could “impose” a Cypriot exit.

“We have no intention of leaving the euro,” said President Nicos Anastasiades this weekend. “The situation, despite the tragedy of it all, is contained”. When it comes to assessing systemic dangers, some may prefer the banal yet far more accurate language employed by former President Bush.